WeWork Inc. (NYSE: WE) leadership disclosed “substantial doubt” about the coworking company’s ability to continue to operate last week and warned of potential bankruptcy risk — but the news isn’t a surprise for those closely tracking the national commercial real estate market.
Still, if WeWork should file for bankruptcy in the near future, it would be the latest blow to an office market facing a seemingly never-ending post-pandemic hangover, with vacancy, sublease space and maturing debt all continuing to mount.
WeWork’s slice of the overall office market is small — it has about 18 million square feet of office space in the U.S. — but WeWork tenants and landlords are having to consider what a potential bankruptcy will mean for them if one of the nation’s most recognizable office tenants closes a significant number of its locations.
“There’s expanded risk and, as you would expect, landlords in the office sector — particularly the core urban centers that WeWork occupies — are looking for any amount of good news, and this is not it,” said Eric Willett, managing director at real estate consultant RCLCO’s management consulting practice.
WeWork did not respond to requests by The Business Journals for comment or context about its financial future by deadline.
What a WeWork bankruptcy could mean for leases
The industry is already bracing for impact.
Jim Van Horn, partner at Barnes & Thornburg LLP and global president of the Turnaround Management Association, said if the company did file for bankruptcy, a few potential paths could be pursued. But the primary issue will be how a debtor deals with WeWork’s leases.
It’s possible WeWork would try to reorganize and emerge out of bankruptcy without a sale and instead become “a leaner, meaner WeWork,” Van Horn said. That would result in even fewer locations for the coworking company, building on a recent trend of the firm consolidating its footprint and closing offices in recent years. Since the end of 2019, WeWork has exited or restructured 590 leases, a company executive said last week during the company’s second-quarter earnings call.
WeWork could sell pieces of its business, including its intellectual property and leases, as part of a potential bankruptcy.
It’s possible terms of WeWork office leases, in the event of a bankruptcy, will be sought to be restructured with building landlords, or leases could be auctioned off, similar to what was recently observed with retailers Bed Bath & Beyond Inc. and Tuesday Morning Corp. But the outcome for WeWork leases and locations may ultimately hinge on current dynamics in the office market.
For example, if a landlord feels they can re-lease a WeWork space or take it out to the open marketplace, they might be less willing to negotiate with WeWork in the event of a bankruptcy, Van Horn said, adding much will depend on factors like the age of the building, where it’s located and whether leases are above or below market rate.
A Chapter 11 filing would give WeWork the right to terminate its leases, The Real Deal reported.
If a landlord feels they can find a more solvent tenant willing to pay more in rent, they will — but others may have to deeply discount their rent just to get something for the time being.
“I’m not confident there’s going to be a huge market of third parties to bid on a WeWork lease, simply because there’s so much occupancy available,” Van Horn said.
Impact on WeWork tenants, landlords
Despite the potential ripple effect WeWork’s future could have on specific buildings or office markets, ultimately — like so much of the broader office market — much will be a case-by-case basis.
For example, WeWork locations fully leased and within top-flight office buildings in a given market will likely have a different future than those in commodity buildings in a city with disproportionately higher vacancy and sublease space, said David Lipson, president of Savills’ North American office.
WeWork, which helped make flexible-office space become part of the mainstream, was one of the pioneers of the highly amenitized and designed workspaces that’ve since become en vogue with the broader office market. With a lot of landlords looking to fill vacancy with flexible office, meeting and event space, there could actually be an opportunity on the horizon for some landlords, Lipson said.
“There’s a shortage of prime space in markets,” he said. But he noted that, in a bankruptcy, things tend to get tied up, and if tenants are given a chance to get out, they will.
Tenants currently leasing space in WeWork offices should now be trying to figure out what their next moves will be, Lipson said, adding flexible-office space is pretty constrained already in key markets, and traditional office leases take time to be negotiated.
Those currently occupying WeWork offices should also be reviewing their agreements, including their rights as a tenant, to understand what their options are.
“You should always understand your options, know what the path is and get ready to act on it,” Lipson said. “If you love your coworking space and a potential stable operator is across the street, it’s likely not going to be available soon.”
Outlook for coworking amid WeWork’s struggle
Although WeWork’s challenges are very specific to the company’s governance, capital structure and how quickly it scaled up — lessons that’ve become the subject of business courses and documentaries — the overall flexible-office sector is facing similar headwinds, though none quite as dramatic as WeWork.
While there may be opportunity for a competitor to gain market share if WeWork should file for bankruptcy and continue to shutter locations, coworking and flexible-office operators are having to contend with weaker demand more broadly as the office market and economy try to regain their footing.
There’s one major difference between how WeWork historically structured most of its leases and how operators today are typically pursuing negotiations, with a industry shift toward operating and management agreements between landlords and coworking-space providers.
Willett said a mismatch between lease terms and financial obligations has proven to be a fundamental challenge of the WeWork business model, adding that disconnect has been viewed by the industry with skepticism for years, even before WeWork’s challenges fully came to light.
And anytime there’s a slowdown in the office market — exemplified most starkly by the Covid-19 pandemic’s impact on and, in many cases, closures of coworking spaces — any business model built on short-term leases gets disproportionately hit.
“The fundamental issue for coworking remains the same: you have a business with long-term, fixed cost leases and short-term variable income,” Lipson said. “Coworking sells flexibility but when everyone exercises the flexibility at the same time, the model blows up.”
Those who track and work within the office market say flexible and coworking office as a concept will continue to have a place in a world where tenants are increasingly looking for flexible lease terms and continue to question how much space they’ll need in the future.
As the economy starts to stabilize, it’s likely the share of flexible office space will continue to grow, as companies will find value in not being tied into long lease commitments, Willett said. Flexible workspace totals about 80 million square feet nationally, or about 2% of office inventory across the U.S., according to RCLCO.
It remains a somewhat nascent part of the broader office market but in places like New York and San Francisco, where WeWork and other coworking operators have scaled up most substantially, a potential bankruptcy by WeWork would hit those markets disproportionately. Despite recent closures, WeWork continues to occupy more than 6.8 million square feet of office space in Manhattan, according to Savills data.
WeWork’s financial outlook is also expected to continue to dampen broader conditions of commercial real estate, including lenders’ willingness to lend to the sector — appetite that’s already waned in recent quarters.
“Office is not in favor right now by the capital markets, that’s for sure, and there is significant weakness in the office market,” Lipson said. “Every hit like this is going to be looked at in a general way, (and) it hurts the ability of even the product that would lease up to come online.”